Edited version of private advice

Authorisation Number: 1051619022428

Date of advice: 16 January 2020

Ruling

Subject: Small business capital gains tax concessions

Question 1

Does the property fall within the meaning of an active asset in section 152-40 of the Income Tax Assessment Act (ITAA) 1997?

Answer

No

This ruling applies for the following period:

30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You purchased a property in 20XX.

At the time of purchase, the property was very run down and has required a lot of work to be done to it.

The property contains a house, a cabin and is XX acres in size.

You built the cabin on the property approximately XX years ago using your own funds. You live in this cabin.

Your child and child's spouse live in the house that is situated on the property.

At about the time that you purchased the property, your child and child's spouse created a discretionary trust named the XXXX ('The Trust'). The Trust became the running entity of the business - the XXXX. The business name is registered as XXXX, trading as the XXXX. The Trust began paying rent to you in the 200X income year.

Your child and child's spouse are the primary beneficiaries of the Trust. You would be considered a secondary beneficiary based on the definitions contained within the trust deed.

You have specific roles that you perform (unpaid) within the business.

You plan to sell the property to the Family Trust in the near future. You expect to make a capital gain from the sale of the property.

All the buildings and the land at XXXX are for business use except the house, which your child and child's spouse law reside in and the cabin, which you reside in.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152A

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 paragraph 152-10(1A) (a)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-35 (1)

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-40(1)

Income Tax Assessment Act 1997 subsection 152-40(4A)

Income Tax Assessment Act 1997 paragraph 152-40(4(e)

Income Tax Assessment Act 1997 subsection 328-125(1)

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Question

Is the property at XXXX an active asset for the purpose of the Small Business concessions in Division 152 of the Income Tax Assessment Act 1997?

Answer

No

Summary

Your property is not considered to be an active asset as you are not carrying on a business, nor are you a connected entity for the purposes of Division 152 of the ITAA 1997.

Basic conditions

Subdivision 152A of the ITAA 1997 outlines the basic conditions you must meet to qualify for small business CGT concessions.A capital gain you make may be reduced or disregarded under Division 152 of the ITAA 1997 if several conditions are satisfied.These conditions are:

Subsection 152-10(1) of the ITAA 1997:

(a)  a CGT event happens in relation to a CGT asset of yours in an income year;

(b)  the event would (apart from this Division) have resulted in the gain)

(c)  at least one of the following applies:

(i)            You are a CGT small business entity for the income year

(ii)           You satisfy the maximum net asset value asset value test

(iii)          You are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership

(iv)         The conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year

(d)  the CGT asset satisfies the active asset test

Based on information you have provided, you expect to make a gain from the sale of your property to the XXXX.The conditions for satisfying the active asset test are found in section 152-40 of the ITAA 1997

Active asset

Under section 152-40 (1) of the ITAA 1997, a CGT asset is an active asset if, at that time,

(a)  you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carriedon (whether alone or in partnership) by:

(i)            you; or

(ii)           your affiliate; or

(iii)          another entity that is connected with you; or

(b)  If the asset is an intangible asset - you own it and it is inherently connected with a business that is carriedon(whether alone or in partnership) by:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you;

Based on information you have provided, you carry out a range of tasks for the business including office duties, delivery of products and weighing of products.In addition, you have acted as guarantor for a loan to start the business.You have also had the expectation from when the business was commenced that you would receive a distribution from the Trust.

Whether a person is carrying on a business is a matter of fact.There is not a precise test, however certain factors will point towards the fact that someone may be carrying on a business.These factors include an intention to make a profit,repetition and regularity of the activity and the size, scale and permanency of the activity.Based on information you have provided, you are not carrying on a business for the purposes of section 152-40 of the ITAA 1997.

A trust cannot be an affiliate. For you to satisfy the active asset test in 152-40 of the ITAA 1997 you need to show that an entity connected with you carries on the business. In your case, this is the operation a certain business.

Connected entity test

The trust that operates the business is a discretionary trust. An entity will control a discretionary trust if the trustee either acts, or might reasonably be expected to act, in accordance with the directions or wishes of the entity and/ or the entity's affiliates.

To demonstrate that entities are connected, you must be able to show that

a)    Either entity controls the other entity in a way described in 328 -125(1) of the ITAA 1997; or

b)    Both entities are controlled in a way described in this section by the same third entity.

An entity will be said to control a discretionary trust if the trustee acts, or might reasonably be expected to act in accordance with the directions or wishes of the entity. As the business is operated through the vehicle of a discretionary trust, you will need to show that you control the trust as follows:

In accordance with 328-125 (3) of the ITAA 1997, an entity controls a discretionary trust if

(a)  a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates

or

(b) both entities are controlled in a way described in this section by the same third entity.

As there is no third entity involved, you will need to be able to demonstrate that you control the discretionary trust as per 328 -125(3)(a) of the ITAA 1997.

There are various ways you may indicate that you have control over the trust. Factors that can be considered when determining control include: the way the trustee has acted in the past, the relationship between the trustee and you and any arrangement or understanding between the entity and any person who has benefited under the trust in the past. Based on the information you have provided, you do not satisfy the conditions for being a connected entity.

Rental income

Section 152-40(4) of the ITAA 1997 contains exceptions to the general rules about what can be active assets. Subsection 152-40(4) (e) provides that a CGT asset cannot be considered an active asset if its main use by you is to derive rent, unless that use is temporary. In your situation, your main use of the property is to derive rent. If, however, you meet the test for connected entities in subsection 152-40(4A) then you can treat any use of the property by the connected entity as your use. However, as you do not meet the test for connected entities, you are unable to treat any use by an entity connected with you as your use. The result of this is that your property is not considered to be an active asset as you are not carrying on a business nor are you a connected entity for the purposes of Division 152 of the ITAA 1997.

Please note, when calculating your capital gain you can utilise the 50% CGT discount on the sale of the property as you have held the asset for at least 12 months.